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The Role of Crowdfunding in Promoting Entrepreneurship

Paulo Silva Pereira

01/21/2012

The Lisbon MBA International (Catolica | Nova | MIT)

Contacts: +351933803759; paulo@ppl.com.pt

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Contents 1. Introduction .......................................................................................................................... 4

2. Research Methodology ......................................................................................................... 7

3. On the Impact of Crowdfunding on Entrepreneurship ......................................................... 8

3.1. Early model validation from small scale operation onwards ........................................ 8

3.2. Pre-sales and Pre-order ............................................................................................... 11

3.3. Incremental rounds of funding and equity and control dilution ................................ 12

3.4. The evolution of the user role and its impact in the entrepreneurial value chain ..... 17

3.5. Innovation and Entrepreneurship promotion in Crowdfunding ................................. 20

3.6. Promotion and Marketing in Start-ups ....................................................................... 27

3.7. On pricing, entrepreneurship and crowdfunding ....................................................... 31

4. Discussion and Concluding Remarks ................................................................................... 36

4.1. Implications and the Future of Crowdfunding ............................................................ 37

4.2. Limits of this study and related suggestions for further research .............................. 38

5. Acknowledgements ............................................................................................................. 41

6. References ........................................................................................................................... 42

List of Figures

Figure 1: The Liquidity Gap in Financial Investments for Entrepreneurs ...................................... 4

Figure 2: Contributions to SciFund Challenge Crowdfunding Experiment .................................. 26

Figure 3: Typical Path of a Consumer Investment via a Crowdfunding Platform ....................... 30

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The Role of Crowdfunding in Promoting Entrepreneurship

ABSTRACT

Crowdfunding is a collaborative initiative, usually via internet, where people network to

collectively raise funds in order to invest in and support projects delivered by other people or

organizations.

Tools such as crowdfunding are born and thrive in a grassroots environment, with a strong

potential to positively disrupt the entrepreneurial generation setting and grow to a position of

significant relevance in society, namely at a time when alternatives to traditional forms of

finance are welcome and the technology to deliver them is abundant.

Entrepreneurship is the act of transforming ideas and projects into economic products or

services. Entrepreneurship related to starting new businesses is better known as start-up

ventures. Entrepreneurs face a series of challenges, from idea conception and business plan

design, to obtaining finance, promoting new products and services, generating revenues and

profits and generally growing and sustaining a business for the long-run. These challenges can

be overwhelming, namely in the start-up phase of a new venture, leaving several ideas on

paper without them having a chance to “grow legs and walk”.

This paper and its analysis offer important insights about the contribution of crowdfunding to

facilitate the attainment of critical factors for successful entrepreneurship. With extensive use

of real practical examples, leveraging previous analytical studies of other crowdfunding

implications and reviewing expert literature, by interviewing entrepreneurs, crowdfunding

platform owners and by benefitting from hands on experience of working in such an

organization, we intend to clarify the impact of crowdfunding in what we considered to be 7

key entrepreneurial requirements detailed further in the introduction section and later in the

body of the paper.

The findings have implications for entrepreneurs, naturally, and for business generation

theory, extending current entrepreneurial guidelines with innovative tools and methodologies

capable of sustaining successful ventures in a newly highlighted cooperative world. We live in

innovative times where the channels for the transfer of funds and resources suffer disruptive

changes with the potential to significantly improve the ability to generate new initiatives for

the well-being of entrepreneurs and all related communities.

KEYWORDS: Crowdfunding, Entrepreneurship, Innovation, Consumer Roles

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1. Introduction

“Access to finance is essential to enhance the competitiveness and growth potential of small

and medium enterprises,” said European Commission Vice President Antonio Tajani,

responsible for industry and entrepreneurship, in December 2011. “In the context of the

current crisis, marked by a fall in lending to the real economy, it is increasingly difficult for such

companies to access loans.”

Entrepreneurs today find a liquidity gap to obtain their much needed finance. Bank loans have

significantly decreased in number and volume and had their acceptance criteria and collateral

requirements have considerably increased. Venture capital and business angels typically

finance larger amounts and require sound proof of significant multiplication of investment

with high returns evidenced in the first 3 years of a venture. Alternatively, seed and pre-seed

entrepreneurs, at the launch of their companies, look for financial support from family and

friends who believe in the entrepreneurs without having to witness clear evidence of a

potential exponential revenue growth in the first years. However, plenty of business

opportunities fail to obtain the necessary funds due to their inability to show enough value to

the investors but also a great majority due to the inability to find investors and bring them on

board their initiative.

Figure 1: The Liquidity Gap in Financial Investments for Entrepreneurs

source: PPL Crowdfunding Portugal

At a time when alternatives to traditional forms of finance are inexistent and economies

around the world stall, entrepreneurs require to find solutions to obtain funding. Conversely,

many investors still hold plenty of liquidity, but struggle to find innovative projects and

investment opportunities to apply their finances into. In this scenario, crowdfunding has a

strong potential to positively disrupt the entrepreneurial generation setting and grow to a

position of significant relevance in society.

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Crowfunding consists in resorting to the crowd to find many small investors to become

involved financially with a project, rather than trying to find a few large investors. It usually

involves financial investments executed online, through the use of social networking, where

sponsors, investors or donators fund initiatives or entities (with or without profit seeking

objectives). There are currently three models of crowdfunding, all of them based on the

solicitation of financial investments online with the goal of funding a project, idea or an

entrepreneurial venture. This solicitation is made to the maximum number of potential

investors possible, through extensive use of online collaboration and communication tools,

applying one of three models.

The first and most common method today is reward-based crowdfunding. These are

philanthropic donations and sponsorships with no financial return on investment where the

investors or contributors are rewarded with creative prizes (usually related to the outcome of

the project) and have the opportunity to get involved with the project and support the

entrepreneurs.

A second method is the peer-to-peer loan. These are loans from several individuals to another

or to an entrepreneurial team looking to fund a project or venture. These loans can involve a

financial return on investment with a pre-agreed interest rate amongst the parties involved or

simply consider the return of the money lent, with no interest rate charged. The opportunity

lies with entrepreneurs that can find it difficult to obtain attractive prices for such a loan from

a financial institution, if they manage to obtain one at all, and investors that also find it difficult

to obtain a decent return on a savings or investment account if all they have are low volume

savings to apply. The repayment of the loan can take several shapes, from a direct bank

transfer to royalty fees or rates on the revenues of an enterprise until so long as the loan and

interest have been paid off.

Lastly there is the equity based crowdfunding model where the project owners are

entrepreneurs who are willing to offer a participation in the equity of their firm in exchange for

the funds invested by the crowd.

In all three methods, we witness a democratization of finance through the disintermediation of

the financial institution that either charged an unreasonably high price for finance or didn’t

concede a loan unless it dealt with an exceptionally qualified candidate (that would probably

not require a loan in the first place). This consists of the utilization of communication and

collaboration channels that enable (remove barriers to) the transfer of capital, wealth,

resources and promotion and consequently offer disruptive changes to the way entrepreneurs

are able to obtain funds for their ventures.

In Holland, the equity based crowdfunding company Symbid1 has just recently been awarded

the Shell Live Wire Award 20112 for the strongest potential contribution to entrepreneurship.

1 http://www.symbid.com/ 2 http://symbid.com/press/20-symbid-wins-audience-award-shell-livewire-award-2011

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The analysis for this study, the research involved and the results obtained and described in this

paper intend to consider and answer the following research questions:

Key Research Question: what role can crowdfunding play in fostering entrepreneurship?

Key related research questions: what impact and in what context does this role affect

entrepreneurship? How significant is that impact?

Crowdfunding is a vehicle that may be especially apt to promote and boost entrepreneurship

and innovation. It can play a critical role, as a resource integrator and a network orchestrator,

to fill the liquidity gap and provide an economy with fuel to its entrepreneurial engine.

In this paper we first introduce the concept of crowdfunding and its potential relation to

entrepreneurship as well as the structure of the paper and its content. On section 2 we

describe the research methodology utilized to reach the relevant conclusions. The main

analysis of the critical factors that affect entrepreneurship and where crowdfunding has a

significant role are explored in section 3. Namely, in section 3.1, we consider crowdfunding’s

impact on the early validation of a business model and on gradually scaling of the operation. In

section 3.2 we document a reflection over the relevance of pre-sales and pre-ordering and

how these benefits can be harnessed with this methodology. Another relevant consideration is

elaborated on regarding the relevance of incremental rounds of funding and the implications

regarding equity dilution and control over the enterprise in section 3.3. The user role within an

entrepreneurial venture and the academic perspectives over it has evolved through time. With

such models of finance, a new role is developed, that of the consumer / financier and it

appears earlier in the “supply chain” of launching an enterprise. This study also delves into

these implications in section 3.4. Another very relevant factor of entrepreneurial success is the

ability to innovate and convert innovation into revenues. Crowdfunding enables this new role

and this paper analyses how and what potential it has in section 3.5. Start-ups also require

investment in marketing and promotion, but typically this is an area that is frequently de-

prioritized due to financial constraints. Again, this tool offers new opportunities in this field

that this paper explores and gives evidence of in section 3.6. Finally, the pricing strategy and

the ability to determine, as soon into the venture as possible, the shape of the demand curve

facing the entrepreneur can be a differentiating factor of success that is enabled and

promoted through crowdfunding. In the last factor analysis, this paper investigates how this

relation can be significant and how such relevant information can be obtained during a

crowdfunding campaign, reported in section 3.7.

In chapter 4 a concluding discussion with final remarks is documented with details on several

implications of the findings and insights into the possibilities that can be explored with the

future of crowdfunding in section 4.1. In section 4.2 the limitations of this study are stated

with recommendations for further research.

In conclusion, the acknowledgements and a list of all the references utilized are documented.

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2. Research Methodology

In this thesis we empirically analyse a set of crowdfunding platforms, including reward-based

crowdfunding, equity-based crowdfunding and peer-to-peer lending. The data for our analysis

was collected via both an extensive review of the academic literature and several interviews

with CEO’s of equity-based crowdfunding platforms and start-ups, namely:

CEO’s of equity-based crowdfunding platforms

Darren Westlake – Crowdcube3

Korstiaan Zandvliet – Symbid4

Interviews and conversations with start-ups and entrepreneurs:

Paulo Silva Pereira, Yoann Nesme, Pedro Domingos and Pedro Oliveira – PPL

Crowdfunding Portugal (Orange Bird LDA)

Limor Shweitzer – Brandmymail

Mariano Kostelec – Uniplaces

Miguel Santo Amaro – Travelabunch

Pedro Colaço – Guestcentric

Daniel Sullivan – Appswell

João Pedro Malheiros – Masterblock

Filipe Santos – Professor of Entrepreneurship at The Lisbon MBA and INSEAD

Paulo Rosado – Professor of Entrepreneurship at The Lisbon MBA and CEO of

Outystems

Another relevant input to the analysis and research done has been the hands on experience of

managing a reward-based crowdfunding platform since August 2011, PPL Crowdfunding

Portugal. PPL is unique for the regional flavour it brings, for the qualities and values of the

team behind it and for the differentiating marketplace innovation it is working on and

developing. It potentiates a truly engaged community looking to exchange funds and skills,

resulting in innovative and creative projects. This is accomplished with local action but global

thinking, where PPL networks with the strongest references in the field and works with

partners and other European and North American platforms to collectively push the envelope

in this new area and promote a strongly positive and impactful democratization of finance.

3 www.crowdcube.com 4 www.symbid.com

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3. On the Impact of Crowdfunding on Entrepreneurship

3.1. Early model validation from small scale operation onwards

Fail early, fail often, fail cheaply has become common wisdom and general knowledge amongst

entrepreneurs. This concept is critical in promoting start-up success and is taught extensively

in the best management schools worldwide. Failure is the best recipe for success, is what it

says.

Filipe Santos5 once analogised with the image of a tennis player. Early stage entrepreneurs are

like tennis players, they see the ball being hit and position themselves on the court taking large

strides to reach a target area. As they interpret the ball’s speed and spin effect, they will re-

adjust their position, taking small steps and shuffling their feet to find the optimal hitting

stance. As the ball hits the ground in front of them, the tennis player will do a final body and

arm adjustment to ensure he will hit the ball strategically, at strength and with accuracy. If the

hit is not perfect, he will have a chance to reply on the opponent’s next strike. If he loses the

point, he will have the next point to battle, provided he hasn’t lost the match. Such is the

“game” of the entrepreneur. He will need to take large strides and position his idea to take his

product or service to the market. As he moves steadily to design, pitch, finance and launch his

project, the entrepreneur will then need re-adjustments, frequent and cheap, along the way,

to fine-tune his offer and ensure he will place it and promote it in the most strategic manner

possible. These adjustments are critical to the survival of the entrepreneurship and they are

required to be understood and executed as early on in the process and with as little cost as

possible. They are also required to occur as often as possible until the final set is played. Then,

if the entrepreneur fails in his endeavour, he will have gathered valuable experience

nevertheless and he will be in a favourable position to launch his next venture, more

confident, with added skills and knowledge and with enough energy, will and cash to launch

his next “offensive”.

This analogy is in line with the recent concepts of Lean Start-up models that look to enable

entrepreneurs to do the most with the least possible and to delay significant investment

rounds and founder dilution to as late in the process as possible. This way they intend to

enable frequent iterations of their business model, product design and overall strategy with

low-cost techniques and early on in the enterprise lifetime.

Agrawal et al. (2011) argued that friends and family are critical to generate early investment to

launch an initiative and that this early investment is an important signal of entrepreneurial

commitment. This signal can and should be used by entrepreneurs, along with other

milestones of success achieved to solicit further funds at a later stage, by accessing sources of

capital at any distance.

5 Filipe Santos is professor of entrepreneurship at The Lisbon MBA International (Catolica | Nova | MIT) and INSEAD

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These authors analyse in particular the music industry where they reveal important changes in

the field over the past decades. Revenues have significantly been reduced due to new forms of

music consumption and sharing such as online sharing, streaming and piracy. Costs, they

argue, have also been reduced. Production and distribution are considerably lower in cost due

to the development of sophisticated yet cheap software and digital distribution. But however

low they may be, costs still exist and financing challenges are the most common amongst

artists in the music industry. Furthermore, they rely on the subjective will of the producer or

editor to appreciate their work, who may then value it and opt for investing in it to

commercialize and, if successful, reap most of the value generated with the sales himself. “In

the vertically integrated industry set-up, large record companies provided both financing and a

full suite of services (e.g., producer, studio, cover design, distribution, auxiliary musicians) in

exchange for ownership of or equity in the artists' intellectual property” (Agrawal et al. 2011).

Crowdfunding has opened up a new playing field in the music industry. Music lovers and

consumers now play an important role of not only purchasing the music they desire and so

provide revenues to the artist, but they are also involved much earlier in the process and help

determine what music is liked, what style, what artist should be promoted and when all this is

determined, they help finance the publication of that work so later they and others can

consume the artistic product. With crowdfunding platforms such as Sellaband6 (this example is

analysed further in this paper) artists are able to test very early the market appetite for their

style, which music in an album gathers the most fans, which music type and which approach

(image, promotion, concert or garage play, etc) best fits their audience. They can do this early

in the process and are able to adjust to maximize success, finding the right balance between

expressing their genuine artistic soul and the commercially valued outcome that will sustain

their career and allow them to continue working on their passion. “As the major labels decline

in importance, artists have fewer options to relieve cash constraints by borrowing against, or

selling equity in, their intellectual property. Crowdfunding helps overcome that constraint by

creating a market for the most salient asset available to aspiring new artists - their ideas,

vision, and future intellectual property - thereby facilitating financing from distant strangers.

Thus, crowdfunding may help reduce an important market failure” (Agrawal et al. 2011).

The music industry is a proven example of crowdfunding applied successfully to enable early,

cheap and frequent failure, thus leading many more artists to success, who would have been

unknown today had it not been for the likes of Sellaband.

The band Nearfield, from Portugal, was successful in raising $50 000 in Sellaband, from 742

“believers”, being the most visited artist on Sellaband with 235 639 profile views (actually 235

640 now)7. This band was unknown in Portugal and unsuccessful in launching its work on the

market (winning the interest of a record label). With their crowdfunding experience, they were

able to directly test the market for the appetite for their work, to incorporate their fan’s

feedback into their music and produce tracks that gained immediate success as was their pre-

6 https://www.sellaband.com/ 7 https://world.sellaband.com/en/projects/nearfield

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tested expectation. Their track “Dance of War”8 in a vocal dub version was one of the

successful later releases.

These bands are now able to walk back into a record label house and negotiate a larger, long-

term agreement, so scaling up their entrepreneurial initiative through the argument that, in

the case of Nearfield, close to 1000 supporters have influenced their style, have supported

them in producing their work and have financed their initiative until that moment. The band

approaches the label with a proven track-record and an existing and consistent generation of

revenues, thus showcasing a relevant opportunity for investment more to the liking of the

biased producer “taste” for music.

“It is this convergence – of new players, on a new playing field, developing new processes for

horizontal collaboration – that I believe is the most important force shaping global economics

and politics in the early 21st century” Thomas L. Friedman

When launching a new product, crowdfunding provides a reliable method of testing concepts

and ideas before committing relevant funds upfront, thus reducing the financial and ultimately

the operational risk associated with a new venture, allowing for more confident entrepreneurs

and a higher success rate of new businesses raised with these tools. In turn, this method also

increases the likelihood of success in the long-run.

With this method, entrepreneurs can understand the ability to scale and its growth rate when

launching a new product. Windowfarms9 is a social business aiming to support amateur urban

farmers that grow their own food. They executed a successful crowdfunding campaign in the

famous Kickstarter crowdfunding platform10.

In this campaign, the entrepreneurs innovated even within an innovative method of

fundraising and set a target financing amount of $50 000 to produce a new hydroponic system

(method to grow plants with no use of soil, only resorting to water and nutrient rich

concoctions) made in China. The financial and fundraising innovation came in the form of a

concurrent secondary financing target, more ambitious, of $200 000. This target would enable

the system to be produced in the US without having to outsource to a cheaper labour nation

the production whilst keeping the assembly within borders. Shivany Ganguly, the Chief

Operations Officer of Windowfarms reveals they wanted to manufacture in the United States

all the time, but reducing cost of the operation had a higher priority. The only way they could

bring the production into the country would be if the end consumer so wished and was willing,

or better yet, committed upfront to a higher volume of sales in order to cover the higher cost

to have the same product produced in their country. Shivany further argued that this would

help them reduce the environmental impact with a leaner supply chain whilst promoting

labour locally and investment in the region.

8 https://world.sellaband.com/en/projects/nearfield/songs/66658-d-o-w-vocal-dub-cd-edit-popface 9 http://www.windowfarms.org/ 10 http://www.kickstarter.com/projects/windowfarms/learn-to-grow-and-share-with-new-windowfarms

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On the 7th of December of 2011, Windowfarms closed their crowdfunding campaign in

Kickstarter. They had gathered investment from 1 577 backers to the total of $257 307, thus

keeping in the United States the manufacturing process of their product, promoting local

labour and having partnered with their consumers/investors to shape the supply chain and

entire operational model of their entrepreneurship. This model test, design and strategic

decision with the participation of the investors was done prior to any sunk cost of effective

investment executed.

3.2. Pre-sales and Pre-order

Li and Fuqiang (2010) in their paper on pre-order strategy conclude that “a highly sought-after

product during the pre-order season provides a positive signal about the product value”.

Further to that conclusion, the “crowd” suggests that “Consumers could potentially benefit

from the pre-order economy because their preferences could be met much more accurately

and they could gain direct input into the invention and design of the products they buy. Since

manufacturers would no longer need to try to persuade people to buy what had already been

made, advertising would supposedly decline in a preorder system. This might mean consumers

would be satisfied with a lower level of total consumption, which is good for the environment.

Finally, companies could benefit from a dramatic reduction in the risk of doing business, since

they would know their product lines would always sell out.” in Wikipedia11

The crowdfunding mechanism, through its commitment of funds prior to any project launch or

production, is a proven method of executing pre-sales and pre-ordering with a guaranteed

commitment from the investor/consumer. In section 3.5, innovation and entrepreneurship

promotion in crowdfunding, an example is given in which a Portuguese entrepreneur plans to

utilize this pre-sales capability to test his product and enable him to achieve a minimum

efficient scale of operation, prior to launching or committing any funds to the cause. This

investor had only imagined he would one day pursue the execution of such a project and

considered the risk too high and the commitment too expensive to eventually set his plan in

motion. Consequently, without the appearance of crowdfunding, he would not plan to begin a

new entrepreneurial venture as he now does.

Yang Chu and Zhang (2010) conclude that “When the margin is large, the seller should adopt a

mass pre-order strategy by withholding information and ordering a large pre-order discount;

when the margin is small, the seller should adopt a niche pre-order strategy by releasing a

great deal of information and ordering a small pre-order discount; and when the margin is in

between, the optimal strategy depends on the amount of information consumers initially

possess”.

In 2010, Jean-Marc Giacalone, an entrepreneur from Milton Keynes in the United Kingdom,

thought their company needed an entrepreneurial boost as it was innovative and new in the

11 http://en.wikipedia.org/wiki/Preorder_economy

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market but developing and promoting 3D printers and printer kits was an expensive endeavor

that required some certainty of success before committing all their energy and funds into it.

The producers of eMaker Huxley 3D printer stated their mission to be: “We are a relatively

new company specialising in the development of open source 3D printers. Our mission is to

make these revolutionary machines available to the mass market, at a realistic price and with a

guarantee of printing success.” They decided to launch a crowdfunding project on Indiegogo

platform12 in order to ensure a minimum scale of operations prior to investing in capacity and

expensive modern technology. The minimum pre-sales they would consider satisfactory to

conclude their product would be well received in the market and had an important role to play

were sales to the volume of $30 000. With investment from 302 customers, Jean-Marc sold

$158 685 worth of several variations of their 3D printer. Their company now goes on to

enlarge the operation and further develop a new and growing niche, secure that they have an

assured demand to fulfil.

Similarly, John VDN and Vitor Santa Maria designed a Hidden Radio and Blue Tooth Speaker

and estimated an investment of $62 000 for injection moulding tools, $30 000 for global

bluetooth certifications and $33 000 for the first production run, totalling an initial minimum

investment of $125 000. For two entrepreneurs with no major source of savings or family and

friends to invest to that amount, it became critical to understand whether an investment of

that sort would generate the required sales and revenues to at the very least not lose any

money from the commitment. On the 18th of January of 2012, John and Vitor raised $938 771

in customer orders for their product, from a total of 5 358 clients. These clients have already

handed their payments to John and Vitor and they are now set to establish the new company

and produce the promised device. Their crowdfunding campaign in Kickstarter13 was a

successful exercise of critical pre-sales to ensure the safe launching of a new enterprise,

averting any financial risk and starting with a pre-set base of customers who are involved and

feel a part of the entire production value-chain.

3.3. Incremental rounds of funding and equity and control dilution

“The entrepreneur and the venture capitalist “live together” for 3 to 5 years, toward the

mutual goal of a public offering or sale of the entrepreneur’s business at a higher price than

management or the venture capitalist paid. Occasionally, the process works smoothly.” (Silver

1985)

Ownership of a company by founders faces dilution when others invest in that company. First

time entrepreneurs seldom realise the extent of this implication and its consequences to their

returns on the personal investment (financial, physical and emotional) and subsequent

motivation to exceed expectations of all stakeholders involved, including them.

12 http://www.indiegogo.com/eMAKER-Huxley-3D-printer-kits 13 http://www.kickstarter.com/projects/2107726947/hidden-radio-and-bluetooth-speaker?ref=live

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For example, if a founder owns 25% of a company and an investor provides funds in exchange

for 25% ownership of the company, the founder does not keep 25% of the entire company.

Rather his share will be diluted down to 25% of 75% that is left after the investor takes his

stake, or 18.75%. This effect occurs repetitively, every time a new investor provides funds in

exchange for equity. When further funding occurs, in larger amounts, the effect is exacerbated

as typically Venture Capital (VC) will demand higher shares for the subsequent rounds of

funding. The first investor will also suffer some dilution and whatever is left after the VC and

the first investor retain their share is what the founder will have a 25% share of.

Furthermore, VC’s will typically also demand a share of options before investing in the

company. These options will also be expected to come out of the share the VC does not own,

further diluting the founder’s equity. An entrepreneur must also be wary of the first investor

looking to protect himself with contractual anti-dilution clauses as this will further increase the

dilution of the founder’s equity. Also, anti-dilution clauses prevent shares to be sold to new

investors at higher prices (thus less equity) to raise capital, as these will typically shy away

from contracts where previous investors have such anti-dilution clauses.

In times of financing scarcity or more demanding criteria to obtain funding, the price of finance

also increases and funds are provided at higher prices (higher equity requirements). These

costs depend on several factors (availability of funds, risk, culture, etc). In 2011, in smaller

countries as Portugal, a start-up promising revenues of over 1 million euros in the 3rd year,

looking to obtain funding of 350 thousand euros in year zero, can be offered the funding in

tranches associated with business growth milestones in exchange for 70% of equity with the

potential to buy back options at nominal value, according to the interviews conducted to the

start-ups listed in the research methodology section.

In 1999 Julia Smith concluded, after evidence gathered through face-to-face interviews with

the owners-managers of over 150 small firms: “Those firms with access to a greater variety of

sources of funding may perform better than those who have fewer sources upon which they

may draw.” (Smith 1999).

Evidence showed some correlations, although Julia Smith admits it hard to establish a reliable

prediction of performance. However, more relevantly, the willingness of the owner-manager

to dilute his equity stake by taking on further outside investment was not proved to improve

performance. Indeed, a majority of firms interviewed, that considered equity dilution revealed

a need to retain over 50% control and equity on the financed venture. The firms that did not

consider any equity dilution were also the majority of those interviewed, revealing how

relevant it was for the founders to retain control and equity over their conceived ideas.

“The evidence on willingness to dilute equity suggests that 40% of high performers would

consider sacrificing a proportion of their stake in the business, or their equity holding, in order

to promote growth. Slightly more of the medium and low performers (49% each) would act

similarly. This figure is probably higher because the latter are more likely to be in need of extra

funding than the high performers. The percentage of equity that each group wants to retain is

between 49% and 53%, on average, with most nominating a desire to retain a controlling

share” (Smith 1999).

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A current debate in alternative forms of finance is around crowdfunding, namely equity-based

crowdfunding (where returns on investment are in the form of equity shares in a company).

Although this form of funding is already permissible in the UK, France, Holland, India and

China, it is not yet so in the USA. It is however in the USA that some of the most successful and

better known crowdfunding platforms exist (reward based, rather than equity based). It is

expected that the Entrepreneur Access to Capital Act H.R. 2930 will soon pass through

Congress on its way to being approved by its most famous advocate, President Barack

Obama14. The same bill has already been approved by the House of Representatives by a large

majority (407 - 17) of rare bi-partisan support. This is an Act aiming to amend section 4a of the

Securities Act of 1933 thus contemplating limited exemptions to registration with the

Securities and Exchange Commission (SEC). In it, crowdfunding campaigns of up to $2 million

per year in funding from individuals are allowed without them requiring registering as

accredited investors. Entrepreneurs will be able to raise up to $2 million with this method of

finance, provided they show audited financial statements. Failing to do so, caps the limit of

funds permissible via crowdfunding to $1 million. The campaign itself would require registering

with the SEC, but not the investors, whose individual investment would not exceed $10 000 or

10% of their annual income (for investor protection). Shares would also not be able to be sold

for the period of one year if the investor is not a registered or accredited investor.

This form of funding is seen as the “future of seed and growth financing for start-ups and

entrepreneurs” (in startupexemption.com). The use of technology, Internet and Social Media

enables fundraising of limited amounts of capital from friends, family and community.

Startupexemption advocates that “it is local vesting and community vetting where only the

winning ideas receive not only funding but shared knowledge, experience and marketing

power… under a framework that provides for investor protection”.

Very relevantly, this form of capital raising, typically enables the kick start of new ventures

without resorting to more expensive and equity dilution solutions of traditional financing.

There are several reasons why this form of financing is cheaper. Crowdfunding relies on the

small investments of many within a community rather than the large investment of a few

investors. One of the downsides of crowdfunding currently is the entrepreneur will not benefit

from the expertise of a wise business angel or venture capitalist network. This can change in

the future as the expertise and knowledge from the crowd can and should be made available.

However, currently, the absence of this expertise contributes to letting this form of finance

remain cheaper. The fact that the investors consist of a large number of individuals or groups

with smaller invested amounts, reduces the personal risk for each of those investors, given

that they behave in an optimal portfolio diversification and risk minimization manner. This

decreased individual risk also contributes to lower the price of the financing conveyed. The

motivations of these investors are also different from traditional investor motivations. They

will look at a return on investment but there will also be a return in the form of a reward and

potential psychological rewards from a personal connection to the entrepreneurs (previously

existing or developed in the meantime) or from a personal connection to the project or the

impact generated by the project. Again, these other forms of return on investment contribute

to lower the financial cost of the funds made available.

14 http://www.startupexemption.com/archives/149#axzz1hwWt0nUa

15

These lower costs of finance through crowdfunding allow for a seed and pre-seed stage

entrepreneur to go through several rounds of crowdfunding without significant equity dilution

and loss of control over his venture, prior to setting up a series B round of funding with

traditional VC (venture capital) or Angel investors. When finally applying for a traditional round

of funding, the entrepreneur may be in a more comfortable equity holding position but also his

enterprise may be further developed along the required economies of scale and revenue

generation line, allowing him to have a stronger negotiating position with traditional investors

(so demanding cheaper prices for that subsequent round of funding).

These rounds of crowdfunding enable a gradual raise of finance in stages.

Why it is best to raise finance gradually, in stages?

Entrepreneurs of start-ups do not have the luxury of obtaining an entire funding for the

lifetime of a venture, in multiples of tens of millions of euros, for a new project, from

inception. Such entrepreneurs may not have solid business repertoires and are considered too

risky for most investors. Such an entrepreneur must first show evidence of success, achieving

key milestones in numbers (revenues, profits, customers, employees, etc.) before proceeding

to further rounds of finance. These will be enabled through increased valuations of his

business. Each round of finance will require the valuation of the company at that stage,

considering future growth potential. The share price of the stock of a company increases with

the value of these valuations. Existing investors are mostly willing to pay the original price of

their initial investment. Therefore, it is in an entrepreneur’s interest to seek investment from

different investors, willing to value and pay the new share price. Such a strategy will enable the

entrepreneur to sell fewer shares but still raise relevant amounts, whilst also increasing the

value of the shares owned by the founders (through an increased valuation, although the

percentage of shares will be reduced). Such high valuations allow for the entrepreneur to raise

financing in more favourable terms.

Brewdog15 is a brewery from the United Kingdom and a good example of equity based

crowdfunding with incremental rounds. It was the first European company to pursue the

strategy of an online IPO. In 2009, they made strong use of social media to leverage their

existing brand asset value and propose an equity offering. However, it wasn’t entirely

successful as it was an expensive procedure, each share was sold expensively and the funding

target originally set was not fully reached. Nevertheless, a funding of £750,000 was achieved in

as little as 5 months. Subsequently, they launched a second crowdfunding project in July 2011,

capitalizing on the experience accumulated, naming it “Equity for Punks”. Brewdog were able

to raise £500,000 in just 2 days and £1 million in 1 month.

Another good example is Trampoline16 that in 2009 also launched an equity crowdfunding

campaign. The project aims to raise £1 million in 4 rounds, of which 2 have successfully

completed. In this case, due to the usage of a system to transact that is not proprietary and

requiring complying with the Financial Services Authority in the UK (FSA), the campaign is

directed at certified high net worth individuals or current shareholders.

15 www.brewdog.com 16 www.crowdfunding.trampolinesystems.com

16

Other very relevant examples of restrained equity and control dilution, albeit with significant

funding acquired through crowdfunding, thus strongly promoting entrepreneurship in various

industries, include projects in several European equity based crowdfunding platforms. In the

English Crowdcube platform17 the project Bubble & Balm from the consumer products industry

achieved £75 000 giving up 15% equity to 82 investors. In the food and drinks sector, in the

same platform, Kammerling’s raised £180 000 through 85 investors in exchange for 23%

equity. Crowdcube registered on the 21st of October of 2011 a world record funding through

this method by financing The Rushmore Group Ltd, in the leisure and tourism industry, with £1

million financed through 143 investors and for only 10% of equity. Interestingly, crowdfunding

businesses also utilize their own tool to finance themselves and, this way, Crowdcube

managed to raise £300 000 through 162 investors, for 9% equity for itself and also for another

platform, Civilised Money, for £100 000 through 121 investors and 10% equity. All of these

happened in the second half of 2011. The Personal Development Bureau (phase 1) raised £25

000 for 15% equity through 68 investors, also in Crowdcube.

Brand Expedition just concluded on the 27th of December 2011 a successful crowdfunding

campaign raising £20 000 with 171 investors in another equity based crowdfunding platform

from the Netherlands, Symbid18 More recently, on the 6th of January 2012, Enviu, a sustainable

business developer from the Netherlands, more famous for its “Sustainable Dance Club” – a

floor which generates energy by dancing on it – raised 100 000€ from 372 investors, offering in

return 1% of their equity. As these events follow each other at faster rates, we are forced to

update this document on a daily basis. As such, and before submitting, we are able to report

yet another successful project with SellAnApp that raised 150 000€ offering 53% of their equity

to 261 investors on the 18th of January 2012.

In France, Wiseed crowdfunding platform19 has successfully funded 11 projects so far, ranging

from €50 000 for 5% equity for project “Le Coeur de Balma” in the real estate industry to €1.2

million for project “Intuilab”, a high tech venture. In this method, however, Wiseed combines

crowdfunding with co-financing by Business Angels, Venture Capital societies, Investment

Funds and other Angel Investors.

In all of these examples, the funded companies, from pre-seed stage entrepreneurship but also

fully formed enterprises were able to obtain financing through crowdfunding and launch new

projects, products or services that would otherwise not be launched due to lack of access to

inexpensive finance or would be launched with considerable effort from the entrepreneurs.

Such a strain in finding funds can potentially put at stake the ability to further develop new

concepts and projects in the future and remove focus from innovating to sustaining debt and

remunerating investors.

17 www.crowdcube.com 18 www.symbid.com 19 www.wiseed.com

17

3.4. The evolution of the user role and its impact in the

entrepreneurial value chain

The user or consumer of an end product or service has played a key role in the marketability of

any good or service. Indeed the user’s intervention and our understanding of it has evolved

through time and become significantly more relevant with direct impact on output of the

entrepreneur supplying the product. Understanding this development and harnessing its

potential has, consequently, also become a key differentiating factor enabling entrepreneurs

to innovate and acquire the benefits of commercializing that innovation.

Ordaninin et al (2010) carefully lay out the role assigned to the consumer in the marketing

literature and how it has evolved over time, concurrent with the evolution of markets. The

“Functional School” of the 1970’s (Barksdale and Darden, 1971) considered consumers to be

critical sources of information to be analysed and utilized in strategy definition. In the “Service

Marketing” school of thought (Fisk et al., 1993), users were co-producers. Eric von Hippel,

starting in 1986 brought us the understanding of users as partners in innovation, with his

“Lead User” theory, where the burning needs of a user and his resourcefulness would become

one of the prime sources of innovation with the added benefit that it is pre-approved as

valuable to the its ultimate beneficiary – the same user. More recently, in the “Service

Dominant Logic” theory of Vargo and Lusch, 2004, end users’ role has been perceived as a key

resource in co-creation of value. The role consumers represent has evolved through time to

carry significantly more relevance, influence and power in the value chain of any corporation.

With the advent of crowdsourcing20 and crowdfunding in particular, the user’s role has shifted

upstream in the value chain. Users may now not only show willingness to pay for a finished

product, but actually commit the payment upfront as a decision to produce and promote that

same product, rather than acquiring it. In this commitment, the user shares part of the

operational and financial risk with the producer and entrepreneur. This involvement and

participation in the production process but more relevantly in the strategic decision making

and design process, represents an evolution of the consumer role to a more sophisticated and

blurry blend between consumer and producer (in some media referred to as the “prosumer”).

Through extensive research based on qualitative case analysis and quantitative data collection

and analysis (both primary data through detailed interviews to leaders of different

crowdfunding businesses and secondary data obtained from the company records, official

company sources and general publically available information), Ordanini et al (2010)

contributed to the marketing literature by unveiling and providing an understanding for this

new “upgraded” role of the user. Within this new role, “the money is invested by consumers to

obtain a return, mostly financial, but sometimes intangible (e.g., status, social esteem,

identification, etc.)… Crowdfunding models include elements of crowdsourcing frameworks in

which the members of a community share ideas to solve a problem or pool their efforts to

create favourable exchange conditions for the community’s benefit. However, in

20 Using the crowd to gather input, ideas, feedback, participation, solve challenges and work on tasks as a means to execute corporate actions

18

crowdfunding, it is not idea generation or bargaining power that emerges from the crowd’s

collective efforts; instead, what the crowd generates is financial support for already proposed

initiatives.” Through social networking, this involvement much earlier in the process and along

the different stages of the entrepreneurial activity lets the user assume responsibility in the

design phase, the campaign setup phase, the production phase and the service delivery phase.

The users, through their decision making, influence and financial support become key factors

in the successful delivery of the final offering. Adding to this intricacy and richness of

involvement, when previously in marketing theory the consumer had an active role of

engagement with the entrepreneur to provide the service but also assumed the role of

consumer of that service, with crowdfunding the user participates, designs, develops, funds

and can ultimately leave consumption to other consumers getting involved further afield.

In the project “Livros de Ontem” in the PPL Crowdfunding Portugal platform21 this blend of

roles from consumer to producer passing through financier has enabled the planning and

design of an innovative new service that if successfully funded with give way to a new

enterprise that will establish a different market concept. A group of university students, faced

with the challenge of requiring expensive new books for their subjects albeit lacking funds to

obtain them, looked for alternative solutions. They realized they could find some of the books

at old bookstores known as “alfarrabistas”. Amongst their colleagues, they also realized some

older students were willing to sell used copies in acceptable state. Through some elaborate

coordination they started to facilitate the acquisition of used books for themselves and some

of their colleagues. But demand for such a solution began to increase and the students realized

they were spending far too much time with the coordination and not making any profit from

this service. As users in need themselves, they gathered around a drawing pad and began to

design an online second hand bookstore for technical books used in some specific

undergraduate courses in university. Understanding what it would take to produce a platform

to manage a marketplace for these desired goods, they launched a crowdfunding project to

finance the development of this platform and acquire enough of a stock of selected books that

would enable them to generate revenues from day one.

This project in PPL is still underway and we can only hope it is successful. The experience

gathered with it, however, is enough to understand this development of the user role, the blur

from consumer to producer and the relevance to innovation and entrepreneurship enabled by

the crowdfunding tool. Firstly the owners of the project began with a pain to address and

developed on their own the solution required. Being users themselves, they utilized one of the

most powerful sources of innovation, user based. This is consistent with the research done by

Oliveira and von Hippel who found that the vast majority of the new services (the functional

innovation) offered by service providers were first provided by users to themselves (i.e. output

of identical similarity for the user). They confirmed these results when analysing data from

research conducted on banking services and in which both banks and users had gains to

achieve with the innovative new service and no barriers existed in the form of regulation. In

their research, 87% of new function was first developed by users. Lead User theory (von

Hippel, 1986) indeed suggests that some users are able to anticipate requirements and needs

long before they become mainstream. Von Hippel goes on to recommend to companies that

21 http://www.ppl.com.pt/investment/livros-de-ontem-a-cultura-para-todos-1045

19

they engage and monetize this lead user innovation and capability to develop new services and

products. Lead user theory enables a very relevant understanding of some characteristics of

crowdfunding investors and users, like the validation of ideas, the support in designing or

redesigning them and the voting right through willingness and commitment to pay for the final

product. But Lead Users as in von Hippel’s theory are not abundant and they are difficult to

manage and coordinate. This brings us to a second point on entrepreneurial and innovative

contributions by the users at large. The involvement of the project supporters in the

crowdfunding campaign for the “Livros de Ontem” project was determinant in generating

other sources of innovation. Investors in the project, are not Lead Users but they also have a

say in the design of the platform. They have opinions that require to be considered, in order to

obtain their financial support. These opinions regard functionality such as peer reviews and

ratings of book suppliers, the ability to post requests or even the demand for specific books.

The latter is especially relevant for the consumer financier as on the launch of the platform,

some investors will demand to have immediately available the books on the specific subjects

they need.

On funding, this crowdfunding project will have had involvement of users to initially innovate

the solution and service to provide, to design the functionality to be available with this service,

to determine the actual products delivered once operational and above all, they will have

funded a new company to provide a service to themselves and the wider public.

Voting rights of consumers can be extremely powerful as an innovation and entrepreneurial

vehicle, especially if the voting community is representative of the overall population of

consumers and has financing power over the entrepreneurs. Ordanini et al. so conclude that

“Consumers become integrators of talent (of others), financial resources (their own), and

promotional efforts (through social networks) in their role as crowdfunding participants”

generating new entrepreneurial ventures in the process.

Furthermore, Ordanini et al. conclude in their extensive interviews that “consumers participate

in crowdfunding websites because they like engaging in innovative behavior.” They will be

involved with the project, the entrepreneurs and the entire initiative, but they are also

motivated by the novel method and the technological and social advance implicit in this

networking environment and its promising potential.

Another important example of this new evolved role of the user and also the role of the

crowdfunding platform involved is the case of Sellaband22. This innovative platform allows

users to invest in an artist and when an investment target is reached the user receives a

reward normally associated with the artist (CD, t-shirts, tickets to a concert, backstage pass,

etc) and also a share of the sales and revenues the artist will achieve. The concept was initially

setup for newcomer artists to support them in their otherwise unpublished work but today

Sellaband has become an important market solution for also renowned artists to promote not

only their works but also their tours and concerts. Before Sellaband, musicians had to follow

traditional channels and be reliant on the decision by an elite and biased group of people that

controlled the industry to decide which individuals had the “talent” to be permitted to record

and publish their work. As the number of artists without a means to deliver their work to

22 https://www.sellaband.com/

20

customers interested in consuming their product grew, solutions like Sellaband appeared to

enable consumer to choose the music they wish to hear and so have artists financed because

they have an audience and not because they have a connection to a producer. In this example

the crowdfunding platform plays a key role of intermediary of supply and demand,

disintermediating the industry at least for a good number of artists and correcting a failure

that would otherwise persist. The result is visible, plenty of new artists are able to become

music entrepreneurs whereas before they would not have that opportunity, consumers are

able to determine which music they like to see produced and they are able to invest and make

a profit in revenue sharing by doing so. Public Enemy’s album “Thank You!!!”23 was

successfully funded to the value of $75 000 with the backing of 1178 fans.

It becomes easier to understand that these new channels of collaboration and engagement

that merge consumers with producers bring about exciting opportunities. It is this conviction

that leads Ley, A. and Weaven, S., (2011) to restate that “businesses that successfully harness

social media in the context of commercial transactions may have significant leverage

opportunities through greater access and information sharing with consumers” and they were

referencing Hagel and Armstrong as far back as 1997.

3.5. Innovation and Entrepreneurship promotion in Crowdfunding

Economic growth reveals a great dependency on the healthy environment for promoting small

firms, as they guarantee a very significant fraction of overall employment and Gross Domestic

Product (e.g., Ley and Weaven 2011).

This is confirmed for example in the Portuguese economic reality and data from PORDATA,

where in 2009 over 95% of non-financial companies had less than 10 employees.

It follows that the financing of start-up companies, the provision of funds to capitalize them,

the ability to launch successfully at low costs and their corresponding chances of survival are

paramount to an economy and its health.

“Low-cost Innovation”

“The price of starting a company has never been lower, and science is unpacking the common

characteristics of entrepreneurs” (Scott 2011).

Today we witness a “Lean Start-up” movement24 that teach us to do more with less. They

profess that resource usage can be optimized and that technological advances have enabled us

to test and validate almost any business model, at very low cost and financial risk, prior to

committing substantial resources to a project. Customer segmentation validation, product

demand test, pricing strategy definition and even a product’s overall viability to be marketed

23 https://www.sellaband.com/en/projects/publicenemy 24 http://theleanstartup.com/

21

can all be accomplished at significantly lower risks than ever before. Innovation itself, a main

source and driver of entrepreneurship, can today be validated and iteratively developed at

very cheap costs.

According to Scott Anthony, in the mid-1980’s Robin Wolaner had the idea to produce and sell

a high quality magazine aimed at parenthood. Her plan estimated a cost of approximately $5

million to conceive this project and launch the magazine. Such an investment obviously

needed a thorough market acceptance test prior to launching into a costly venture to produce

something that might ultimately be rejected and be of no interest to the market. Robin

innovated by sending a sample issue of the magazine to selected targets, to validate demand

for her product. Each sample sent out had a reply card, postage paid, to provide feedback to

Robin on their wish to subscribe to the magazine. She invested $150 000 to execute this

“market research” exercise. The results were very positive and Robin moved ahead with her

project, later finding a successful exit strategy when she sold the magazine to Time Life, Inc.

The initial investment in the innovative market testing strategy ended up being a good

investment, albeit not cheap, when her final return summed up to $10 million.

In contrast, in 2010, a would-be entrepreneur discussed his project proposal with

crowdfunding site PPL. He wanted to bring to Portugal a specialty magazine of a field that was

quite specific and professional. He was sure there would be plenty of interest in it as he

worked in this field and often had conversations with colleagues about the magazine. Every

time one of them got a hold of the original English version of the magazine, it would circulate

until the edges were soft and crimped. He had contacted the original publisher and had a

spoken agreement to be the sole importer and translator of the magazine. To his surprise, the

publisher also agreed to give him exclusivity of the magazine to any Portuguese speaking

country, which includes Brazil, Angola, Mozambique, etc, adding up to a significant potential

market size. Rui quickly opened his excel and put together a cost calculation to understand

that to fulfil the minimum order quantity of 300 magazines per month, to cover the costs of

translation and to pick up the tabs on marketing, legal services, company registration and all

he would require around €15 000 for the first year, assuming he would not receive his salary

from this firm and that some assistant work could be shared from his other employer. A cost of

€5 per issue seemed a reasonable promotion price to launch it on the market, being that

specialty magazine consumers would be willing to pay more than that once they realized its

value. And for this price he would cover the annual cost of bringing at least 300 magazines per

month and if he had at least 300 investors at €5 he would achieve €18 000 which would well

cover for promotion costs and any other reward cost to support his crowdfunding campaign.

Most relevant of all, Rui had not required extensive calculations to understand his financial risk

with launching this project. That risk was minimal. The cost of launching a crowdfunding

campaign was zero. The cost of promotion was minimized through the strong utilization of

social networking and other low cost tools. The cost of not achieving his financial investment

request was only that he would suffer a disappointment and would have seen his late nights

and weekend hour efforts disappear into well wishes from an insufficient number of investors.

Additionally, the crowdfunding platform would charge nothing if he didn’t achieve his funding

target and his opportunity cost would not surpass the time, effort and promotion investment

he would have made. On the other hand, his only cost of a successful funding would be the 5%

22

commission this platform would charge. This, in any case, had been accounted for in the cost

structure of his crowdfunding project.

How does Rui’s and Robin’s cost to innovate compare? In the case of Rui, his costs were less

than 0.1 % of the investment of Robin Wolaner for a very similar exercise in the 1980’s (with

no crowdfunding). It would be innovative, namely as we are speaking of a specialty magazine

inexistent in the Portuguese language, that would help push the boundaries of the field in

countries where this language is spoken. The financial risk is lower as the investment is lower

but also through the commitment mechanism, whereas Robin relied on intention revealing

cards she hoped would hold true once she made the investment to produce the magazine, Rui

could count on hard cash pre-sales (if successfully funded) to ensure his first year minimum

order was fulfilled. Anything else he sold during that year would be at a profit and would serve

the purpose of reinvestment to grow the business or pay himself of the assistant the much

deserved compensation.

Through crowdfunding, Rui is able to replicate the exercise of innovating in the market to

launch a new enterprise, at a fraction of the cost required decades earlier in a very similar

exercise done by Robin without access to social networks.

In the words of Scott (2011) “The low cost of innovation affects all of us by giving us more

options. Think about weight loss. Instead of just relying on willpower or going to a specialist

weight-loss clinic, innovators have given us an incredible variety of dieting applications in

Apple's App Store… Further, scientists increasingly throw out new mechanisms to lose weight,

with ideas transmitted in a blink of an eye on Facebook, Twitter, and other networking tools.”

Nevertheless, it is not enough that Rui and now Robin can innovate at a very low cost in the

21st century. They must possess qualities and behaviour patterns that enable them to think up

these new ideas and build on other’s ideas to bring about positive disruption (Scott 2011). In

essence they’ve discovered what they believe is a critical associational thinking where

innovators connect several ideas that may not be obvious to link. More importantly, we find

that social networking tools and namely new tendencies in work, like crowdsourcing, or

funding, like crowdfunding provide a means to explore the approaches that gather the right

stimuli to enable these connections.

The researchers, Scott (2011), identified four approaches that enable these stimuli to be

conveyed to innovators.

Questioning: posing critical questions that strengthen or do away with significant

challenges (e.g. what if I had 300 pre-sold subscriptions to my magazine? What if I

were able to test the Portuguese market for this specialty product prior to any

financial commitment to do so?)

Networking: the possibility of engaging with people with diverse cultures and rationale

that provide different parameters to evaluate ideas. In the example of the project

“Formiga Juju”25 successfully funded in the PPL platform, networking enabled investors

to have an opinion and contribute to the development of the children’s story. Indeed,

25 http://www.ppl.com.pt/investment/a-formiga-juju-na-cidade-das-papaias-1017

23

upon confirmation with the author, the last third of the story was fully crowdsourced

and was not at all what she had originally thought of. These investors networked with

the promoter of the project all the way from the United States, Brazil, the Middle East,

Asia and Africa to her base location in Mozambique)

Observing: this stimulus is apparently obvious, but current access to information is

paramount in enabling the availability of the required information as well as

technological advance is required to sift through the overload that this very same

information can be. Although these tools don’t offer any particular mechanism to

enable a developed observation method, the sheer volume and proliferation of

crowdfunding projects today provide a very rich hunting ground for references, ideas

and incredible innovations in almost any field

Experimenting: aligned with the fail early, fail often and fail cheaply concept,

successful innovators require plenty opportunities to fail and try again. Tools that

allow for iterative experiments with full collaboration and interaction with the

potential target customers will enable rapid development of idea and evolution of

these to meet undiscovered or as yet un-communicated user needs.

People that engage with a project, originally to buy a reward or support an entrepreneur,

become much more involved and come to “own” the project. The crowd has contributed with

content, skills, resources and funds to several projects. For some projects, the crowd itself has

become the main promoter, voicing their support in a viral networking effect. These

individuals or groups, that participate in the process of funding via this method have a

tendency already to be innovative themselves, trying new ways of interacting with project

promoters, companies and other investors or consumers. Naturally they are also moved by

their identification with the social nature of the exercise, with the cause of the project or the

entrepreneurs behind it and this creates incentives for them to become involved with the

initiative. A relevant segment will also be the consumer or investor that plans to receive a

return on his investment and that is a major motivation that will always be driven by, amongst

other factors, how innovative a project is and what expectations of a future profit it may

generate. This in turn promotes an environment that promotes and pushes for innovation, by

rating and preferring projects and ideas that bring disruptive and useful functionality with a

promise of a positive impact in society, users and investors.

Velocity of innovation

In the field of economics, the velocity of money is a critical factor used by economists to help

understand how robust an economic system is. It measures the rate of circulation of money to

make transactions and purchase goods and services. This is not the supply of money, a static

view of the amounts of currency available in a system, but a more relevant indicator of healthy

economic activity, where money is put to regenerating use rather than being “hidden under a

mattress”. In The Crowdfunding Revolution, Kevin Lawton and Dan Marom argue that the same

logic applies to the velocity of innovation “it… paints a very clear picture of the stifling

characteristic of our intellectual property system with respect to today’s innovation and rate of

24

change”. They create a further analogy to our planet’s natural resources, in which these are

extracted, processed and converted into products thus generating economic and social

benefits to all. These benefits enable other developments and the conception of new ideas.

The more efficient is the process of “extraction” and processing of new ideas and the more

iterative and faster it occurs, so will the velocity of innovation likewise increase, generating

increasing benefits to the development of new enterprises and economic activity that transact

on innovative products and services. Social networking applied to finance (a.k.a.

crowdfunding) enables a steady supply of idea flow with collective improvement and

scalability of impact through increased connectedness and absence of barriers to the flow of

resources, funds and capabilities. Crowdfunding thus promotes this velocity of innovation with

relevant impacts to the frequency and quality of the ideas generated for new

entrepreneurship.

Overcoming barriers to innovation and entrepreneurship

Freire (2000) lists the main obstacles to the creation of new enterprises to be the perception of

risk by the entrepreneur, the perception of capital scarcity for finance, the perception of

personal inadequacy to execute a project, the perception of competition or a highly

competitive environment, the perception of the status quo that is not to be changed, the fear

of failure and of loss (over indebtedness) and myths such as racism or chauvinism. In a

potential vicious cycle, these fears may impede the drive to create new entrepreneurship and

consequently innovate. The lack of innovation due to these fears in turn strangles

entrepreneurship as no new ideas are generated to be commercialized.

Crowdfunding is a tool that enables a significant lowering of the financial risk involved in a new

venture. With its ability to execute pre-sales and to gather a minimum efficient scale of

demand and support prior to any commitment of funds or resources, it allows for an

entrepreneur to invest minimally (as per several of the examples listed in this thesis) in the

promotion and communication of the crowdfunding project, prior to any major investment in

the actual execution of the venture. Other risks are then involved with this kind of exercise,

but they are arguably considered less severe to the entrepreneur than the risk of financial loss

and bankruptcy, such as social risk (of not being able to prove his point and sell his idea),

intellectual property risk (if not done right, an entrepreneur may reveal too much when

soliciting investment and enable imitators to replicate his idea, ultimately faster than the

entrepreneur would have expected) and reputational risk, different from social, in that there

would eventually be only so many failed crowdfunding attempts by an entrepreneur before he

would be generally dismissed by the crowd for future investment opportunities.

Capital scarcity and the general liquidity freeze for seed and pre-seed stage entrepreneurs is a

serious current challenge. Tools that tap into a large crowd of investors, where the equation is

inverted from a few investors times a large contribution to many investors times smaller

contributions open new doors and possibilities to obtain the much needed funds.

Crowdfunding can achieve funding success rates to the order of 50% of all the reward-based

platforms that publicly report their results and also of PPL, and slightly lower for equity-based

crowdfunding platforms, as per the sharing discussions with Darren Westlake (Crowdcube) and

25

Korstiaan Zandvliet (Symbid), to the order of 30 to 40%. This success rate, although apparently

low, is relevant in eliminating the perception of lack of funds that may prevent an attempt at

proposing a new and innovative entrepreneurial venture. Entrepreneurs see this success rate

as an almost 1 in 2 chance of success with a much more significant benefit which is the

transparency of the process and the logic for succeeding or not in financing one’s project. This

transparency also allows for the more savvy entrepreneurs to study the major success cases

and quickly pick up on the critical success factors (such as the idea itself, its interest to a

community, the supporters, the communication and promotion of the idea and the

crowdfunding platform (its quality, seriousness and professionalism) the projects succeeded in

obtaining their required funds.

The remaining barriers, Freire mentions, as the perception of personal inadequacy to execute

a project, the perception of competition or a highly competitive environment, the perception

of the status quo that is not to be changed, the fear of failure and of loss (over indebtedness)

and myths such as racism or chauvinism find strong mitigation forces in collaborative online

tools due to the collective and cooperative experience they provide. The wisdom of the crowd

and the sharing of that wisdom empower the entrepreneur and provide him with the access to

knowledge, skills and resources enabling him to venture into a project lacking some of those,

as long as he’s clear about them and solicits this participation. Ultimately, crowdfunding will

evolve to the ability for an investor to reap the benefits of the return to his investment,

whether his contribution comes in the form of capital, resources, skills and knowledge or

simply promotion (networking access and diffusion). These marketplaces for projects, ideas,

funds, resources, labour, equity and promotion have the potential to mitigate if not eradicate

any entrepreneurial perception of risk of inadequacy, too competitive an environment, an

inalterable status quo and fears of failure or unfounded myths. Pre-testing, pre-selling, pre-

validating an idea and gathering strong support from future consumers and investors solidifies

a project and minimizes many of the barriers to innovation and entrepreneurship generation

existent today.

Scientific Research and innovation

In a more direct impact on innovation, crowdfunding has been proved to contribute to

scientific research by enabling the funding of science based projects that bring about new

developments.

In just over the period of one month, a test was executed to validate this capability of

crowdfunding. The SciFund initiative was setup26 for scientist to raise money from the larger

anonymous crowd to fund their research. In all 49 scientists from 5 countries agreed to the

experiment to try and crowdfund their research. The challenge occurred between November

1st and December 15th of 2011 in the crowdfunding platform Rockethub.27 In this short period

of time, the experiment proved successful by raising $76 230 from 1440 contributors. Some of

the projects successfully funded were “Send John to the Jungle” where the expenses of $1000

26 http://scifund.wordpress.com/ 27 http://rockethub.com/

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for doing research in Yucatan by anthropology student John G. were fully covered, another

was “Ancient Roman DNA Project” where a pilot study of ancient DNA was funded to the

amount of $10 171, also “Cancer? Yeast has answers” was successfully financed where $2 835

were invested in cancer research. Other projects included “Support Zombie research” where

$5 000 will finance the understanding of brain infecting parasites and “Artificial Photosynthesis

at NCSU” which will enable the learning of how to capture and store the energy of the sun

using chemistry. These are some of the many projects funded with this experiment and that

stand a chance of turning into successful entrepreneurships that look at commercializing the

findings of any of them. Table 2 below depicts the evolution of funds coming in to this

crowdfunding experiment in such a short period of time.

Figure 2: Contributions to SciFund Challenge Crowdfunding Experiment

source: http://scifund.wordpress.com/

In another example of direct relation to scientific research, a scientist from Instituto

Gulbenkian da Ciência, a renowned scientific research foundation in Portugal, is crowdfunding

her research of the Lemur primate in the island of Madagascar. Some of the rewards for

investing in this valuable research come in the form of a copy of the final report of the

research, a personal discussion with the team of scientists behind this and other investigations

and other related merchandising goods. For €2 000 anyone can become a part of the team

that supported and enabled the research of this species existent only in Madagascar28.

28 http://www.ppl.com.pt/investment/conserva-1041

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3.6. Promotion and Marketing in Start-ups

“The groundswell is a social trend in which people use technologies to get the things they need

from each other instead of from companies.

The groundswell phenomenon is not a flash in the pan. The technologies that make it work are

evolving at an ever-increasing pace, but the phenomenon itself is based on people acting on

their eternal desire to connect. It has created a permanent, long-lasting shift in the way the

world works. How to deal with this trend, regardless of how the individual technology pieces

change… we call groundswell thinking” (Li and Bernoff 2011)

Power to the people is the motto and the drive behind this groundswell. It is a revolution in

disintermediation that enables people to connect and demand or protest their rights and more

relevantly, channel the resources amongst themselves to attain the desired objectives of a

community, group or individual. These are the “protesters” that made Time Magazine’s Person

of the Year 2011, connected by technology and information and resource sharing. The free

transfer of such resources allowed for a tremendous power stance that overthrew dictatorship

in Tunisia and Egypt. Generations of secular tradition were broken when women in Saudi

Arabia gathered to demand the right to drive (not that driving was secular, but woman’s place

in society in that culture would never contemplate such public manifestation). Occupy Wall

Street gave visibility to the “99% - the budget office report tell us that essentially all of the

upward redistribution of income away from the bottom 80% has gone to the highest-income

1% of Americans. That is, the protesters who portray themselves as representing the interests

of the 99% have it basically right, and the pundits solemnly assuring them that it’s really about

education, not the gains of a small élite, have it completely wrong”, Paul Krugman in the New

York Times.

Today, the ability to broadcast a message, gather support for a movement or bring investors to

a cause has considerably changed for the better. People are able to communicate and diffuse

messages effortlessly and with very low costs. To entrepreneurs, this is a fundamental change

that opens the door to new and exciting opportunities.

Start-ups and small and medium enterprises, face a paradox of a key success factor. Marketing

spending is critical to obtain a much needed visibility, namely when commercializing an

innovative product or service, however tight financial constraints leave very little investment

to service this strategy. Also, with inexperience frequently come minor miscalculations in

expenses or revenues which can prove determinant in cutting costs in apparently non-

prioritized activities as marketing. This can lead to a vicious cycle in which smaller revenues

provoke cuts in promoting sales, which in turn lead to decreased revenues. Small business

owners and start-up entrepreneurs look for low-cost marketing tools to promote their

products and services in creative ways.

Of all the interviews conducted with the start-ups for this research, no single definition of

affordable promotion strategies appeared consistently, ranging from strategies that are overall

inexpensive in cost, to marketing investments that represent a small percentage of total

spending or strategies that are cost effective and boost sales more than proportionately to the

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spending. These companies are typically bootstrapping (companies that are trying to survive a

launch at minimum operational costs and maximum revenues and profits) and will search for

marketing options that are effective and low-cost.

These entrepreneurs also state that on launch of a company, it is quite relevant to

communicate broadly and announce the new product or service, but that the emphasis must

quickly switch to relationship marketing and converting informed potential customers to

buyers. Again the focus is on early revenues and profits to ensure minimum scale and

ultimately survival. They see marketing as a multi-faceted social engagement in a strategic

continuum beginning from the very first steps, even prior to funding. Naturally the connection

to traditional marketing media is a requirement, but the bootstrapping strategy frequently

leaves this out for a further, sounder revenue state, development stage of the business.

Crowdfunding provides the entrepreneur with a listening audience of sophisticated

investor/consumers that wish to be a part of the new product or service. This tool has proven

to not only be an effective fundraiser, but also a highly efficient marketing and promotion

delivery channel. It was born in the groundswell and it serves the purpose of creating channels

for the easy transfer of resources, funds and projects. Entrepreneurs are able to engage with

this audience without having to invest in any initial advertising. Several crowdfunding

platforms such as PPL only charge a fee upon successful funding, with no upfront costs. The

main buzz around a project in crowdfunding comes from that groundswell exercise, mostly

through word of mouth or “word of mouse” (social networking). Very often this results in free

coverage by traditional media.

Windowfarms29 is a good example of project a successfully funded in the crowdfunding

platform Kickstarter. Referred to earlier as having initially set a target of $50 000 for producing

the product in China, they suggested a further goal of $200 000 for producing it in the US, so

helping “to keep the environmental footprint of our product low, reduces supply chain

complexity, and supports local economic growth,” according to Shivani Ganguly, the Chief

Operations Officer of Windowfarms. In order to achieve this second target, they would require

a much higher sales volume and correspondingly enough coverage and promotion to attract

such a crowd of investors. On the 7th of December of 2011, Windowfarms concluded their

crowdfunding project, having raised $257 307 from 1 577 investors. A critical contribution was

the strong support from other media forms that were attracted by their participation in

Kickstarter and so provided good coverage of their online petition. This coverage in traditional

media would otherwise not exist or at least happen at a very costly investment. Windowfarms

was covered in Gizmodo30, Fast Company31, Treehugger32, Inhabitat33 and Forbes34. This media

29 http://www.kickstarter.com/projects/windowfarms/learn-to-grow-and-share-with-new-windowfarms 30 http://gizmodo.com/5860545/this-gorgeous-mini-hydroponic-farm-turns-your-home-into-pot-and-produce-heaven 31 http://www.fastcodesign.com/1665498/wanted-the-first-windowfarm-kit-from-a-pioneer-in-micro-gardening 32 http://www.treehugger.com/green-food/windowfarms-now-available-clumsy-people-short-attention-spans.html

29

coverage was determinant in attracting many potential investors to their project, having

resulted in a strong supportive community from as far away as Austria and Australia. This

groundswell tapping strategy generated enough evangelists for the project, at zero cost, thus

enabling a very strong upfront marketing strategy, which was critical in ensuring this

entrepreneur was enormously successful and able to launch a full-fledged enterprise with

upfront customers, revenues and profits guaranteed, including all the necessary viral

marketing investment.

Similarly, at PPL, projects like Bubblenet, Patagonia Luso-Expedition, Formiga Juju and My Tea

Break benefitted from the opportunity of large scale exposure through the participation in the

first International Crowdfunding Event in Portugal35 with the presence of the two top equity

based crowdfunding platforms globally (Crowdcube and Symbid) as well as PPL themselves.

The event attracted an audience of over 450 attendees and was also webcasted to the world.

These projects on their own would struggle and require significant investment to achieve such

a level of exposure. Subsequent to the event, all the projects attracted further media attention

in the form of television interviews and traditional media (newspapers and magazines)

involvement. Although most projects were quite localized and did not manage to explore fully

the international visibility, they also benefitted to exposure at reference international media

aggregators such a Crowdsourcing.org36.

All this project promotion and marketing actions provided very critical exposure and

messaging in a broad scale, critical to the success of the projects but still resulting in zero cost

investment from each of the projects.

Other than the overall marketing effect of participating in a crowdfunding campaign, the

process of fundraising via this tool itself has powerful educational marketing and consumer

behaviour insights that force an entrepreneur to quickly progress through this learning curve.

In the research conducted by Ordanini et al. (2010), where several interviews were conducted

and data analyzed regarding representative crowdfunding platforms globally, a trend was

verified in a project’s funding lifecycle through this method. At PPL through the successful

finance of 6 projects (as of January 2012) and several others in the lifecycle currently, the same

trend is already confirmed. Figure 2 illustrates this trend and the rationale follows.

33 http://inhabitat.com/window-farms-lets-green-thumbs-grow-fresh-veggies-indoors/ 34 http://www.forbes.com/sites/daniellegould/2011/12/07/windowfarms-raises-230k-on-kickstarter-to-manufacture-new-system-locally/ 35 http://www.ppl.com.pt/pg/evento-28 36http://www.crowdsourcing.org/editorial/lisbon-hosts-first-portuguese-

crowdfunding-event/6919

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Figure 3: Typical Path of a Consumer Investment via a Crowdfunding Platform

Source: Ordanini et al (2010)

In this lifecycle, the first phase reveals an important flow of support and investment up to

approximately half of the project’s target finance request. This accumulation is rapid and

occurs mostly through the support of individuals or organizations that are closely connected to

the project or the network of the promoter of the project.

This is the “Friend Funding” phase and requires some but not extensive investment in

promotion, communication and marketing, as the natural excitement of the new project and

the social networking capability of the founders generally suffice to attract the quick and

relevant support.

Achieving the target is a much more challenging task and the second stage represents the

major hurdle that determines success of the finance operation. In this stage, although the

increment in contribution is not significant, it is determinant in reaching the “Engagement

Moment” after which, once more, through very little effort contribution comes steadily. At this

second stage it is where the promoter appeals to the “crowd” and requires gathering critical

support from investors that are not in his close network and are unrelated to the project.

Typically these investors seek to purchase a reward or wish to contribute to a cause that’s

inherent to the project (can be social or not, with local impact or even just somehow related to

an area of interest). Investors that are attracted in this phase can contribute with any amount

and if the rewards are appealing enough and strategically set, accompanied by a relevant

message, they can contribute with significant amounts.

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The primary reason of failure of a crowdfunding project is the inability to trigger the crowd buy

in process. A few projects (< 50%) reach the “Engagement Moment”. Once reached, a chain

reaction is triggered where investors then wish to become a part of the endeavour and see it

as a last chance to participate. In this final stage, just a few strategic messages conveyed in

appropriate channels to the investor target suffice to reap the investment required for full

finance success. Again in this phase, investors are mostly individuals with no original

connection to the project that have been following or got word of the potentially successful

project that is close to its end. A “race to be in” ensues where people speed up their

investment understanding that it is a last chance to gain access to a project that will no longer

be available in the short term. Closely related investors may also participate, particularly if the

project requires a final push.

Due to its criticality and augmented challenge, phase 2 investors are the preferred target of

both project owners and a platform as PPL. Investors that are not necessarily connected to the

project, that are willing to contribute to a cause or invest/purchase a reward and that are able

to support with significant amounts are a strategic target that will contribute to the success of

a project. Communication and promotion of one’s project to these investors is determinant to

ensure successful funding.

Some of the typical groundswell tools to listen to your crowd, talk to it and finally energize it to

join and invest in an entrepreneur’s project include low-cost marketing tools as Search Engine

Optimization, email marketing, comment marketing, community building, blogging, video

posting, forum active participation and general viral promotion of word of mouth.

Crowdfunding platforms such as PPL offer the connections to all these marketing tools as a

standard service at no cost, thus enabling a critical strategic tool of marketing and promotion

to early stage entrepreneurs and helping them succeed at their endeavour to launch and grow

new ventures. Furthermore, the media exposure these platforms themselves benefit from is

extensible to the projects that participate in them, at no cost, thus providing an added

promotion capability which proves to be of critical value add for the entrepreneurs involved.

3.7. On pricing, entrepreneurship and crowdfunding

A most challenging but relevant issue an entrepreneur must tackle is how to price for his

product or service. This becomes ever more challenging as the business is new (start-ups) and

as the product or service is innovative and without any historical consumption data (demand

and supply) to be leveraged on. There isn’t a single formula for a pricing strategy, but there are

relevant guidelines. One of the key success factors for an entrepreneur to launch a new

venture in a sustainable long term fashion is the ability to correctly determine and set the

pricing strategy. Experimentation with pricing on a fully launched operation can be fatal and

there seldom is a second chance to establish a positioning based on pricing.

Before understanding what role crowdfunding can play in this important strategy

determination, there is first an acknowledgement of some relevant factors that affect this

strategy such as knowledge of the demand curve and a customer’s willingness to pay,

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positioning and pricing role, cost of goods/services produced, critical environmental factors

and the key objectives of an entrepreneur’s pricing strategy.

A key factor in determining the right pricing strategy lies in understanding how this pricing will

affect demand. Entrepreneurs need to do, at the very least, some basic market research to

understand this and be able to conclude at a certain price what percentage of consumers will

buy the product or service and at different prices levels, what percentages will purchase.

Likewise, the positioning of a product or service is strongly influenced by its price strategy.

Common goods are priced differently to exclusive luxurious goods for example. Consumers do

tend to believe strongly that one gets what one pays for. Also, market competitive positioning

is highly dependent on how one determines price relative to potential competition.

The cost of goods to produce is determinant in that an entrepreneur must turn a gross profit

(price minus cost of goods sold) to sufficiently cover his fixed overheads in order to turn a

profit. The calculation of fixed and variable costs associated with the product or service

requires being accurate as does the cost of goods sold (the cost allocated to each product or

service delivered) and the fixed overhead (which is associated with the overall company size

and operation and will remain stable unless the company changes dramatically in dimension).

Too many entrepreneurs, specifically in the early stages of their ventures, underestimate these

costs and find themselves struggling to get past the survival threshold.

Other key environmental factors include legal requirements affecting price or other external

factors such as competitor reaction to an entrepreneur’s price setting (will a price war be

triggered?).

Equally relevant are the pricing objectives set by the entrepreneur. Whether there is a short-

term maximization of profit objective or revenue maximization, or whether reaching

economies of scale in the minimum time possible is fundamental, the pricing strategy will

directly have an impact on these objectives. Other objectives could be a differentiation tactic

or just maximizing the overall profit margin.

All of these factors and the objectives set will then allow the entrepreneurs to determine what

type of pricing strategy to follow. These could vary as cost-plus a margin strategy, target ROI

(return on investment) pricing, value-based pricing (where the price is based on the value

created for and perceived by the customer) or even aligned to a perception of fair pricing.

Crowdfunding is a relevant tool to extract key information from the market regarding some of

the critical factors affecting a pricing strategy. It can also play a key role in the objective

accomplishment of the strategy, namely for enterprises that seek to prove their market

relevance prior to further, complementary, rounds of traditional funding (business angels,

venture capital, etc.).

The selection of rewards associated with a given price in a crowdfunding campaign is

paramount to obtain some of this critical information. Carefully thought crowdfunding

campaigns allow for the determination of many of the factors listed above and the testing of

the objectives set with the pricing strategy.

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The setting of different level prices for different quantities of the product or service or for

different features or quality details helps the entrepreneur determine part of the demand

curve he is facing. In the “Curly Cable for iPad and iPhone”37 project in the Kickstarter

crowdfunding platform the entrepreneurs are able to set prices for different quantities, where

unit price decreases with higher quantities ordered. They are also able to set different prices

for different types of consumers as in the case of high quantity orders typical for online

resellers. When in such a case, they have more than 500 investors interested in their product

(and consequently have far overcome their initial funding target), they are able to prove the

general public demand for such a product and to plot a relevant demand curve for the

product, given the different price options and different types of consumers (sales models of

business to consumer and business to business).

Slight variations in product quality or features also allow testing for relative demand. By pricing

differently the PDF version of a children’s book with no illustrations from the physical full

version, the author of “Formiga Juju”38 project in PPL was able to ascertain consumer

preference for electronic cheaper versions at a given price, relative to the full physical version

of the book. Equally relevant, by pricing the same for 2 copies of the physical book or for 1

copy of a high quality limited edition version, she was able to determine the comparative

demand for the 2 types of editions and also to extract considerable value of those customers

that value access to the limited edition concept and a differentiated product (available only

through this crowdfunding campaign). This is also a good example of how a more luxurious

good was correctly positioned as such by using not only the appealing description but the price

reference that indicated it was worth 2 of the regular quality version books.

The author of “Formiga Juju” in PPL Crowdfunding platform from Portugal is an author who

aspires to become an entrepreneur of her own works. However, some inexperience in the field

of management led to minor miscalculations of pricing strategies, namely the costing structure

associated with the production of the book. As is her intention to further the experience and

produce other stories and books, the crowdfunding experience was critical in helping her

determine accurately this cost structure and understanding what were exactly her overhead

costs and fixed and variable costs. Prior to mass scale production of the books and price

positioning in the market, the crowdfunding project allowed for determination of these cost

structures with minimal financial risk. She is now ready to venture into new projects with deep

understanding of all variables that go into the production costs.

Crowdfunding also plays a critical role in achieving an early entrepreneur’s pricing objectives.

When the need is for short-term revenue maximization, rapid achievement of economies of

scale is bolstered by pre-sales enabled through crowdfunding, prior to any significant financial

commitment to the project. Indeed a minimum efficient scale for pre-project launch may be

defined and set as the crowdfunding target to be reached, by setting price accordingly and

testing for quantity selling outcome. As a simple example, if an entrepreneur decided to sell

uniquely designed watches, he may calculate that of a certain design, nothing short of 300

watches sold at unit cost plus a 5% margin will suffice to venture into such an endeavour.

37 http://www.kickstarter.com/projects/1117194589/curly-cable-for-ipad-and-iphone 38 http://www.ppl.com.pt/investment/a-formiga-juju-na-cidade-das-papaias-1017

34

Crowdfunding allows him to launch such a project where that design is offered at that value. If

he obtains the 300 investors or more, he is ensured the minimum efficient scale for his

production. This maximization of short-term revenue, even prior to project launch may be

critical in establishing an important market share and showing higher revenues, at a small

profit or even a loss, proving that the company will likely reach profitability. For example,

amazon.com delivered very high revenues for several years until finally showing a profit. Its

market capitalization was a sign of the investor confidence in the generation of relevant

revenues and determinant in obtaining subsequent rounds of more traditional funding.

Crowdfunding is typically not an end in itself, regarding funding, but may be the key to

launching a credible operation that is attractive to other investors further down the line of

financing needs.

Short-term profit maximization goals may not be the ideal pricing strategy for achieving long-

term profits. However, bootstrapping entrepreneurs (companies that are trying to survive a

launch at minimum operational costs and maximum profits) often have cash flow as the

primary concern. Smaller companies, in start-up mode, typically resort to this strategy, to

enable self-sustainability as early as possible and also because it attracts venture funding in

achieving profitability as early on as viable. A critical factor to allow for short-term profit

maximization is the ability for a firm to extract the maximum value of consumer surplus

possible. This translates to the ability to price as close as possible to a consumer’s willingness

to pay which may vary in time and so discriminate pricing to these different consumer values.

In Belleflame et al (2011), “compared to traditional funding, crowdfunding has the advantage

of ordering an enhanced experience to some consumers and, thereby, of allowing the

entrepreneur to practice second-degree price discrimination and extract a larger share of the

consumer surplus. Since the consumers who pre-order are those with a high willingness to pay

for the product, these will generally constitute the bulk of the “crowd". However, an

entrepreneur is generally unable to identify these consumers. The entrepreneur must then use

some self-selecting device so as to induce high-paying consumers to reveal themselves. The

sort of ‘community experience’ that web-based crowdfunding offers may be a means by which

the entrepreneur enhances the perceived quality of the product for the consumers who agree

to pre-order it. In this sense, crowdfunding appears as a form of menu pricing (i.e., of second-

degree price discrimination). The disadvantage is that the entrepreneur is constrained in

his/her choice of prices by the amount of capital that he/she needs to raise initially to fund

production: the larger this amount, the more prices have to be twisted so as to attract a large

number of crowdfunders, and the less profitable the menu pricing scheme. The model

highlights the importance of community-based experience for crowdfunding to be a viable

alternative to traditional funding. If the entrepreneur is not able to create such benefits, no

consumer will find it worthwhile to pre-order the good, unless a discount is offered. However,

crowdfunding then becomes less profitable compared to traditional funding. Also, the analysis

shows that crowdfunding is the most profitable option only for lower levels of finance. Indeed,

crowdfunding yields higher profits only for small amounts where the entrepreneur faces no (or

limited) constraints in his/her price setting between the two types of consumers while still

securing enough up-front financing. As the amount required becomes larger, the entrepreneur

is forced to distort more the prices so that more consumers are willing to pre-order and thus

35

the entrepreneur can collect up-front more money. This in turn reduces the gains from price

discrimination.”

Initially seen as merely an alternative financing tool, crowdfunding can in fact play a

substantial role in the pricing strategy of an entrepreneur, supporting with demand

determination, positioning setup, cost structure validation and achieving critical pricing

objectives. As pricing is one of the most critical success factors for new ventures and successful

entrepreneurship in general, crowdfunding may thus play a significant role in enabling quick

and cost efficient learning and setting of adequate pricing strategies.

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4. Discussion and Concluding Remarks

Throughout this paper and now in the concluding remarks, we have not addressed directly, but

it is our conviction that a clear answer has been achieved for our key research question.

Key Research Question: what role can crowdfunding play in fostering entrepreneurship?

Key related research questions: what impact and in what context does this role affect

entrepreneurship? How significant is that impact?

The answer is complex but unequivocally positive. Crowdfunding has a critical role to play in

the promotion of entrepreneurship and the tool is set to change the way we see finance and

the involvement of consumers and investors today. The impact is very significant which is why

it leads notables as president Barack Obama to defend equity Crowdfunding as a key solution

to creating much needed new enterprises and jobs.

A problem faced by entrepreneurs at the beginning of their entrepreneurial initiative is to

attract outside capital. Crowdfunding has the potential to become an important alternative

method of raising funds for start-ups (e.g., Schwienbacher and Larralde 2010). Indeed, it has

the potential of becoming a mainstream method for such purpose. Entrepreneurs require

access to tools and resources that allow them to competitively push new ideas and ventures

into the marketplace. As we have seen, crowdfunding can have a positive impact in critical

success factors for entrepreneurs such as in early model validation, pre-sales and pre-ordering,

in reducing equity dilution whilst obtaining the required funds in incremental rounds, in

harnessing the contribution of the end user, partnering with him to innovate, design, promote,

finance and launch the new venture. It can also support in a low cost promotion strategy with

sophisticated marketing online tools and can have a fundamental role of support in the

determination of the demand curve for the product or service to be delivered, allowing for

upfront optimization of the pricing strategy to extract maximum value from consumer surplus.

The satisfaction derived from all involved and the sense of accomplishment with a visible

impact has been extremely rewarding to the owners of crowdfunding platforms such as

Crowdcube, Symbid and PPL. Most of the projects funded thus far would not have found their

way out from the drawing sketches, so the most relevant lesson has been that the ability for

the crowd to validate, curate, support and then own, promote and finance an initiative is

something not to underestimate. It is also a great responsibility for a platform to intervene

enough to ensure trust, efficiency, security and growth of such a mechanism, but understand

that such movements are desired and driven by the crowd and ultimately belong to it.

This model, however, is not yet a substitute for traditional methods of funding such as

business angel investment, venture capital, private equity, loans and stock-market initial public

offerings. The more traditional forms of raising capital will continue to be the most adequate

solution for the majority of financing requirements. Collective finance through social

networking has an important role in our current society already, and crowdfunding can

become the privileged solution for seed, pre-seed and even mid-stage entrepreneurial

endeavours.

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As a new trend in global finance, this concept has yet to be fully understood and explored. It

shows promising positive potential impact, which is why it already proliferates so strongly

across the world and why Europeans have adopted higher impact models such as equity-based

crowdfunding and Americans currently seek to legislate and open the door for this model too.

However, crowdfunding is as yet fully researched and understood, it presents relevant risks

and requires at best some standardization and criteria for evaluating a platform’s performance

and ideally some form of regulation, common across nations, to guarantee investor protection,

intellectual property rights, prevent online piracy and other illegalities such as money

laundering.

4.1. Implications and the Future of Crowdfunding

Ordanini et al. take a step further in researching the role of crowdfunding platforms in the

market. Crowdfunding firms are “network orchestrators”, they create the required

environment, organization and enablers to allow for resource exchange and integration among

all intervenients. The authors go further and extend the rationale to specify that crowdfunding

companies orchestrate a certain type of network, where the customer/financier plays the

central role and not the actual firm. Such firms have optional orchestration modes, where they

are able to intermediate where previously there was no intermediation. This typical in a loan

based crowdfunding model with peer-to-peer loans. Alternatively these firms can replace a

standard intermediary, as in the case of the music industry where the crowdfunding platform

replaced the biased label producer or they can desintermediate the entire medium by

cancelling the participation of a previous service provider. Trampoline39 is a closed circuit

crowdfunding platform where only accredited investors may participate. In their words,

“Instead of raising money from venture capital firms Trampoline is using a technique called

“crowdfunding”, raising smaller stakes from a community of smart private investors.”

Trampoline has succeeded in desintermediating the Venture Capital firm in their own finance

process.

As per Ordanini et al., “crowdfunding is thus a phenomenon that has the potential to

significantly alter the roles of service organizations in value networks.”

President Barack Obama is known to defend the approval of a new bill exempting financial

operations, under certain rules, from the standard IPO (Initial Public Offering) requirements

due to the estimated potential of this method of finance to generate considerable

employment over the next five years through the creation of new firms.

These online collaboration tools are set to change the spectrum of entrepreneurial

development and start-up firm generation. Exactly how remains to be understood and

researched in order to not only manage but also promote it and extract the strongest benefit

and potential from it. Lawton (2010) goes so far as suggesting a “perpetual motion machine of

innovation” can be explored through crowdfunding. Rather than criticizing how realistic this

39 http://crowdfunding.trampolinesystems.com/

38

vision is it’s relevant to understand that we are in a position to push the boundaries of

entrepreneurship creation and armed with an exploring spirit complemented with the

required safeguard for the intervenients in the model, rather than a sceptical one, we are

ready to jump to the next level of financial democratization globally. Lawton (2010)

acknowledges that such a “machine” in the thermodynamics scientific field is not possible. But

in financial terms, he provokes the reader by imagining an investment fund created to be

utilized only through crowdfunding and in new, innovative technologies and firms. By

assuming this funds performs well and is able to generate returns which are then channelled

back into the same type of investments. Lawton (2010) call this “Venture Capital meets

Crowdfunding” and he pictures a nation (his book is dedicated to the first nation to fully grasp

and explore the potential of crowdfunding) where this method would be utilized to manage a

nation’s Research and Development budget. This fund, being profitable, requires no new

funding through other means as taxation. In his words “this is the perpetual motion machine

of nationally focused innovation. Fully transparent, accountable, and expressive of the

collective will of the people it represents.”

In the interviews conducted, we have also found a belief that crowdfunding is not only a tool

to channel funds to Entrepreneurs but has the potential to become a marketplace for funds,

resources and projects. For example, if an entrepreneur was seeking 50 000 € funding, they

know that a part is for an accountant’s work and another part is for a designer to develop their

image. Also from experience, they know such professionals who are willing to contribute with

this work, instead of funds, and still are entitled to earn a share of entrepreneur’s equity. A

crowdfunding platform can thus become a marketplace that provides a financing solution and

a return on investment in the form of equity and / or revenue sharing. It could also allow

investors to pledge not just cash, but resources (skills and labour) and promotion drive (if one

promotes a project in a significant network and from that effect the project gains other

investors, one should be remunerated for this promotion effort). This functionality can be

enabled in a marketplace offering full engagement possibilities like virtual meeting rooms,

ratings and reviews, referrals, forum, online help assistance and other social networking viral

tools.

4.2. Limits of this study and related suggestions for further research

The theme under study, the technology involved and the sociological implications are all very

recent in history and have very little research and study applied. This in itself is the most

relevant limitation. Although this thesis reports plenty of facts and practical examples of

applications of crowdfunding exercises in a series of industries and firms, the fact is the

available statistics are still insufficient to establish full causal relations with enough reasonable

certainty and from there formulate hypothesis that are applicable in a more generalized

fashion. Mentioned below, the risk of default (a project that is crowdfunded and then does not

deliver according to promise) in all platforms across the world is less than 1%. Although these

are extremely positive results, in the case of the PPL platform, for instance, that statistic is 0%

it would take only a few projects going sour to raise the statistic to an exceptional level so

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early in the history of collective finance online. One of the main reasons a lot of platforms go

to extra efforts to execute some due diligence and ensure such cases are minimal to non-

existent, at no extra cost to its investors or project promoters, is precisely to ensure these

statistics remain at impressive low scores and so the prove the potential and benefits of such a

mechanism.

This alternative method of finance also poses some relevant risks that require addressing. This

study can and should be expanded by researching these risks and exploring possible mitigation

actions, consequences and other risk management options. When we look at the risk of

default from a project, the existing statistics since 2005 (when crowdfunding in its current

form appeared – collective finance has existed for a considerable time, albeit not in a social

networking environment) are revealing. It’s common understanding that the transparency and

collaborative effect of this mechanism as well as the natural follow-up on the project by the

crowd create strong incentives that keep default rates at extraordinary minimums. A research

by Deutsche Bank in 200740 reveals this tendency where default rates are significantly lower

than those existent in the case of bank loans. The personal relationship established between

investor and project promoter, the common interest in the final outcome and the fact that

there exists no financial intermediary in the process are some of the reasons that explain this

phenomenon. A comparative among some platforms reveals default rates as low as 6%41.

Another limitation, among all the virtues of a collaborative system is simultaneously one of the

long standing reasons for governments to require providing public services. Such a system will

select interesting and innovative ideas that might otherwise not come off the paper they were

thought of in and turn them into implemented projects with palpable outcomes. However,

many required innovations or impactful projects may not receive enough attention from the

general public to be funded and launched into new enterprises. This is one of the downsides of

all things communal. Only the ideas generally approved by a community are developed and

turned into full fledge offerings. This limitation becomes evident and easier to understand with

the examples given on crowdfunding for scientific research. Several relevant and much needed

projects have been financed and are now in the stage of being developed. But there is at least

an equal number of projects, apparently less relevant or understood to the untrained eye,

therefore less supported and eventually not financed, that have just as much relevance, if not

more, to human kind and any community therein. One may argue that better communication

and promotion is required in such cases, but how much communication and promotion is

enough to convey to the general public that investing in some exquisite biotechnology

research, with a low probability of success and possibly very relevant benefits but only a

decade from now, is a good investment opportunity?

Similarly, in the “velocity of innovation” concept that Lawton (2010) details, the results may be

quite incongruous. “With the increasing connectedness we enjoy, the idea supply will keep

growing, although the economically stimulating “velocity of innovation” may be very

incongruous across various countries. If the nations which enriched themselves with the spoils

of leading previous industrialization, are not quick to adapt to the new revolutionary forces,

40 http://www.dbresearch.de/PROD/DBR_INTERNET_DE-PROD/PROD0000000000213372.pdf 41 http://investmentinstartups.wordpress.com/crowdfunding-2/

40

than history may well record a provocative irony; newer developing nations may effectively be

“mining” or otherwise exploiting the “idea supply” resources of previously developed nations.”

When we analysed the potential of pre-ordering in crowdfunding we also understood from the

works referenced that there exist limitations to this potential. Yang Chu and Zhang (2010)

reveal “We also find that while pre-order benefits the seller across the board, the relative gain

is most pronounced when a mass pre-order strategy is viable (the normalized margin is not too

low) and retail alone is inadequate to realize the profit potential (the margin is not too high

either).” Similarly, Li and Fuqiang (2010) alerted to the fact that “contrary to conventional

wisdom, we have demonstrated that advance demand information can be detrimental to firms

when facing forward-looking consumers: (1) It may hurt the seller's profit in the pre-order

season through its negative effect on the pre-order price. (2) In the presence of price

guarantees, it can also hurt the seller's profit in the regular season through its negative e

ect on the regular-season demand. Due to such negative effects of advance demand

information, the seller needs to carefully decide whether to accept pre-orders, and whether to

provide price guarantees with pre-orders. We find that the seller's strategy choice depends

critically on the relative market sizes of the two types of consumers.”

Naturally any of these pose relevant opportunities for further research, in pre-order the

different authors point to the possibility of introducing more sophisticated consumer valuation

models and in the default rates risk a thorough research into the specific cases, causes and

motivations would surely reveal important facts to support the extension our understanding of

these. This applies to pre-orders and to all of the 7 factor of entrepreneurial promotion

through crowdfunding, further research will improve our understanding of these phenomena

and enable better extraction of value from them whilst mitigating and minimizing the inherent

risks.

This study did not explore further other risks like intellectual property rights, investor

protection and interoperability across platforms. Further research is advisable in this field to

determine all the possible consequences of negative results derived from these risks as well as

important mitigating actions to put in place to avoid the risks becoming issues.

One of the critical success factors in such methods of obtaining finance for entrepreneurs is

also one of its risks if managed inappropriately. The more a project owner exposes himself and

his idea, the better chance he has of attracting investors to his cause. Disclosure of detailed

information and potential of his venture will result in raising the attractiveness of the same to

potential investors. Unfortunately, that same disclosure and transparency may make him liable

to intellectual property rights infringement. We live in an open source world and there is a

current debate whether such protection makes sense. However, while the debate continues,

an entrepreneur must, nevertheless, take precautionary actions to avoid being easily copied.

The crowdfunding platform owners we interviewed all confirmed that they perform some sort

of offline advisory role to project candidates where they advise them to reveal enough to

entice his potential investors and show the true potential of his idea, but he shouldn’t reveal

too much that would allow the idea to be copied and implemented prior to his launching.

There will be a shady zone between these two areas, and the challenge there remains with the

entrepreneur. Another relevant fact raised in the interviews is that a natural risk mitigation

41

setup exists regarding intellectual property rights. An entrepreneur stands a good chance to

implement a new venture successfully if he possesses the skills and knowledge to do it, the

motivation and energy to execute it, the actual idea concept clearly thought out and the

financial means to do so. When launching a campaign through collective finance, the

entrepreneur is typically missing only the last part, the funds to do so. In this scenario, it is

extremely difficult to copy or anticipate the entrepreneur’s idea and launch a venture through

intellectual property infringement over that individual or group. To copy an idea is not too

difficult, to replicate the conjunction of critical success factors all together at a certain period

in time is much more complex.

With the development of crowdunding the interoperability across different platforms gains

relevance. Projects should be able to easily migrate from one platform to another or integrate

sub-projects across different platforms. A part of a project can raise funds via one platform

while another part of a project (be it complementary or independent) through another

platform. For the purpose it becomes very important to have standards, both technical and

process related, across platforms, to ensure seamless integration across. This study can also be

extended and improved by exploring this implication and understanding the risks involved with

the lack of interoperability and the potential of having it broadly available and implemented.

5. Acknowledgements

The authors are grateful to the CEO’s of the Crowdfunding platforms interviewed (Korstiaan

Zandvliet and Darren Westlake), to all the start-ups and their founders that contributed with

insights and knowledge to this work and indirectly to all researchers who have made their

work available to learn and build on, as is our wish that this one may serve the same purpose.

The authors are particularly thankful for the guidance and overview of Professor Pedro Oliveira

from Universidade Católica Portuguesa.

42

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